Win the Trade War and Lose on Your Investments

By Jim Walker on Wednesday, February 13th, 2019 |
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The trade negotiations between the USA and China are coming to a head. Will there be genuine gains for the USA? We have written how both the USA and China have issues that they see as crucial to their national prosperity and security in our article about if the trade war becomes permanent. However, neither side wants to suffer the economic pain that could come out of a protracted trade war. China, especially, is seeing economic difficulties on the horizon and needs to do something sooner rather than later. So, there may well be a deal forthcoming. However, from the USA point of view, it is probably possible to win the trade war and lose on your investments. How is that possible?

Win the Trade War and Lose on Your Investments

An article in Market Watch caught our eye. They note that a trade-war win might not be a victory for the stock market!

Sometimes losing can pay dividends in unexpected ways, and that seems particularly true in the case of stocks and trade.

For the past five decades, the U.S. stock market has comparatively outperformed when the trade deficit widened and vice versa, suggesting that even if the U.S. emerges victorious from its trade war with China, investors may have few reasons to rejoice.

At face value, it may seem counterintuitive, but for the U.S., which relies on trade to fuel its economic juggernaut, a deficit can actually be a sign that all is well.

They provide a graph that demonstrates how this has worked since 1970.

How Will a Trade War Win Relate to the Stock Market?

We have no reason to dispute the figures provided by Market Watch. It would indeed appear that when the trade deficit goes up that the stock market rises too. And the opposite seems also to be true, at least for the last half of a century. But, a relationship does not prove cause and effect.

In the Market Watch article they note that when the rest of the world is doing well economically and the U.S.A. is not doing so well, US exports may rise but US imports will fall off because people have less money and buy less. So, the balance of trade is better but the stock market suffers. And, when the USA is doing well economically, people buy more foreign products and the balance of trade worsens. Thus the balance of trade worsens but the stock market goes up.

The point is that in the past both the stock market and the U.S.A. balance of payments have been driven by consumer spending in the U.S.A. albeit in different directions. Will this be the case with a new trade deal?

What Kind of Trade Deal Can We Expect?

Many believe that as pressure mounts on both sides to make a deal, that a deal will happen, but it will not be as comprehensive as the U.S.A. wants or needs. Both China and the U.S.A. see trade, intellectual property, and control of whole economic sectors as existential issues. Thus both sides want more than the other can give. This especially applies to the Chinese Communist Party which fears for its survival if it gives up its heavy-handed control of the Chinese economy and Chinese society. Thus, there will likely be a deal and continued wrangling over issues into the distant future. And, to the extent that a trade deal results in a better balance of payments for the U.S.A. that may not be a good thing for your investments. But, the reasons might be different than what Market Watch describes.

A bone of contention on the US side is that China makes promises regarding access to its markets and protection of intellectual property and does not follow through. The US negotiators want to build in automatic increases in tariffs that will kick in when the Chinese continue with their old tricks of promising and not delivering.

It could be that higher tariffs on Chinese goods may become a permanent part of the equation. Either Trump will raise tariffs because there is no deal or tariffs will be triggered by non-compliance on the Chinese side.

Tariffs and the Balance of Trade

Tariffs by themselves do not affect the balance of trade. Rather, the consumer’s choice to pick another product due to the high tariff-added cost of a foreign product my result in purchasing from a domestic producer. That is the ideal solution for the U.S.A. if it wants to bring more manufacturing back into the USA. However, the Chinese have taken over whole sections of industry. For example, 70% of electronic production capacity is now in China. The bad end result of high tariffs for US consumers is that they simply pay more for imports from China because nobody else is producing what the consumer wants! When that happens, it raises prices for consumers in the USA but does not help the balance of payments. And, because consumer dollars are now going to pay for tariffs, it hurts the economy as well. If that turns out to be the case, there will no longer be a better stock market when people are buying more foreign products.

On the other hand, if the China give ground and really let US and other foreign companies into the Chinese market and if they really turn around and protect intellectual property, and if they finally loosen controls on private industry, there could be an economic boom in China that would benefit any number of US multinationals. But, while you are waiting for an outcome of trade talks, a little re-balancing of your portfolio to include a few offshore stocks might well be in order.